IT’S viewed as an insider’s secret for the affluent: a legal way to invest in hedge funds and other potentially lucrative assets, all without paying taxes on the gains.

Private placement life insurance, as it is known, is still unfamiliar to many wealthy people — and trickier to design properly than even some savvy investors realize, tax lawyers and financial advisers say.

“It sounds so good — ‘I can invest tax-free and get the money’ — but it’s actually very complex,” said Jonathan Blattmachr, a retired estates and trusts partner from the Milbank Tweed law firm in New York.

Private placement life insurance is an investment wrapped inside an insurance policy. The Internal Revenue Code treats the taxation of insurance differently from that of investments, like stocks or hedge funds, and does not levy federal income tax or the 15 percent capital gains on a life insurance policy when it pays out upon the death of the holder. So by stuffing an otherwise taxable investment inside a tax-free life insurance policy, investors can reap the compounded gains of that investment and the death benefit, all tax-free.

The insurance is a form of variable life insurance whose cash value depends upon the performance of investments held in the policy. It is particularly lucrative because hedge funds, which trade frequently, otherwise often carry the 35 percent short-term capital gains tax.

William Waxman, a principal at Waxman Cavner Lawson, an insurance broker for the wealthy and a financial adviser in Austin, Tex., said that demand for hedge funds, even in a down market, “is driving a lot of the private placement insurance market.” Still, he said, the private placement life insurance industry was relatively small; the cash value of all policies outstanding amounts to perhaps $4 billion to $5 billion. While brokers pitched the policies to many family offices on the East Coast, he said, West Coast offices appeared less tapped.

There are other lucrative benefits besides the absence of income taxes.

When structured properly, the gains and the death benefit can escape estate taxes and go to your heirs tax-free when you die. If structured through an offshore entity, like a foreign trust, the gains can remain out of reach of creditors or those who might sue you.

But investors appeared to be shying away from the foreign variant, Mr. Waxman said, in part because “you have very sophisticated estate planning lawyers in the United States, but they don’t necessarily have offshore practices.”

Investors may also be able to borrow up to 90 percent of the gains from the policy without paying taxes on the loan. One exception is when the policy is structured as a modified endowment contract, or M.E.C.; then, the amount borrowed is taxed at ordinary rates, typically 35 percent, and may carry a 10 percent penalty tax.

Investors who buy an M.E.C. version do so solely to pass on the death benefit free of income and estate taxes to their heirs, not to access gains tax-free before then. The Internal Revenue Service considers the policy an M.E.C. if the investor has paid in all the premiums due over the first seven years — a limitation intended to prevent the rapid financing of tax-free benefits.

Investors must also meet several hurdles.

They must be an “accredited investor” and “qualified purchaser” as defined by the Securities and Exchange Commission, which means they must earn at least $200,000 a year and have investable assets of at least $5 million. The insured must qualify medically for an insurance policy — in other words, not hooked up to life support in intensive care.

But tax lawyers say the most difficult hurdle concerns restrictions around the choice of the investments. The “private placement” part means that the investor must be willing to choose, from a list preselected by the insurer, the bonds, stocks, hedge funds or other investments in which premiums will be invested. In other words, you can’t try to stuff in your separate hedge fund investment, a move that can run you afoul of the Internal Revenue Service.

And you can’t stuff in paintings or other valuables, Mr. Waxman added. He said the policies were not good for those wanting to invest in private equity, because the latter can be difficult to convert to cash.

Gideon Rothschild, an estates and tax lawyer in New York who specializes in offshore versions of the policies, said the people who can buy them “are control freaks and tend to think they can invest better than anybody, including the hedge fund manager,” and thus often shy away from them.

Though the policies require only a couple of premium payments, they are hefty. Insurers that sell them typically require at least a $1 million prepaid premium for a $10 million policy, and others require $5 million. Some policies have a value as high as $100 million or more, with the total premiums due ranging from $10 million or more each. Big sellers include MassMutual, the American International Group, New York Life, the Phoenix Companies in Hartford and Boston, Prudential, John Hancock and Crown Global Insurance.

But the various fees that can be owed in addition to the premiums are typically well below fees for other forms of investable insurance.

They can include a one-time sales load charge, a required annual mortality expense, the monthly cost of insurance, a state premium tax and a deferred acquisition cost. If a trust or foreign corporation is set up offshore to house the policy, there are other fees, including one paid to the trustee of the entity that owns the policy.

If the policy owns hedge funds, investors may also be required to pay the typical 20 percent cut of profits and a 2 percent management fee to the fund.

The total fees associated with an onshore policy vary, but Mr. Waxman said that, as a guideline, “we try to make the total cost of the whole thing 100 basis points or less of the cash value” of the policy. (One basis point is one one-hundredth of a percent, so 100 basis points would be 1 percent, or $50,000 on a $5 million policy.)

Lawrence Brody, an estate planning partner at the Bryan Cave law firm in St. Louis, said that “you have to have the financial capacity to buy one of these, so that it’s not too tempting to have a $100 million policy on your life and somebody who’s a beneficiary who might want to kill you” to collect the death benefit. “You will want a billion or so in net worth, and the insurer will probably even require it.”